EUR: Lagarde can give the euro some relief
ECB President Christine Lagarde probably faces a harder task than her US counterpart today. The latest PMIs confirmed the eurozone economy is heading towards a period of sluggish growth, which now makes any hawkish statement a harder sell.
At the same time, Lagarde and her ECB colleagues are probably aware that the window for one last hike to curb the still non-negligible service inflation is closing fast. In other words, if the ECB pauses in September, it may well not get a chance to hike any more given the deteriorating economic outlook.
As in the case of the Fed, we have already heard from a couple of ECB speakers. Ultra-hawkish member Joachim Nagel unsurprisingly said it’s too early to think about a pause and restated the bank’s data-dependent approach. A slightly more moderate Governing Council member, Boris Vujcic, also echoed such reasoning.
Our perception is that Lagarde is unhappy with the market's recent scale-down of rate expectations in the eurozone (a September hike is only 40% priced in), and she may prefer to keep overlooking some evidence of worsening growth and stick with a pure data-dependent approach. Ultimately, if inflation surprises on the upside, the chances of a hike in September would rise quite significantly in our view, especially given the deteriorating growth outlook, which means that could be the ECB’s last chance to raise rates.
The EUR-USD two-year swap rate differential has widened (in favour of the dollar) to the 140-145bp levels, which were last seen in February/March. We think there is room for some re-tightening after Lagarde’s speech today, and for EUR/USD to enjoy a relief rally after the break below 1.0800 saw more bearish momentum building overnight.
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